TDFs Reduce Risk for Retirement Plan Participants

August 23, 2012 (PLANSPONSOR.com) - Retirement plan participants who choose their own investment options are generally exposed to greater risk than target-date fund (TDF) investors, according to research from Principal Financial Group.

In analyzing a subset of 2.4 million defined contribution accounts, The Principal compared do-it-for-me participants who use a target-date investment option with do-it-myself participants who select their own allocation and services. The research found that generally, do-it-myself participants were less diversified by asset class and number of investment options, rarely used automatic rebalancing to meet their investment goals, and at younger ages, frequently had much less exposure to equities.

The research showed that do-it-myself participants are using an average of two to four investment options across the board, compared with the average 15 to 20 underlying investment options, representing a variety of asset classes, within the typical target-date portfolio.

Among the youngest investors analyzed, those opting for a do-it-myself approach generally had less exposure to equities, and may be missing out on one of the key ingredients to greater retirement savings: the potential power of compounded earnings. Equity exposure among do-it-myself investors who are far from retirement tended to differ significantly from the average target-date investor in the same age group.

The average do-it-myself participant born after 1987 had nearly 30-percentage-points lower equity exposure (54.7%) within their investment portfolio compared with the 83.95% within a target-date investment option.

With time, participants’ investment allocations may become out of alignment with their goals. While participants may rebalance on their own to realign their allocations to their intended strategies, the analysis found that do-it-myself participants are rarely selecting automatic this option. Only 2% of do-it-myself investors elected an automatic rebalancing service. Auto-rebalancing is typically a built-in feature within target-date investment options.